Corporate FinanceBerk DeMarzo Test Bank Chapter 16.docx
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Corporate FinanceBerk DeMarzo Test Bank Chapter 16.docx
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CorporateFinanceBerkDeMarzoTestBankChapter16
CorporateFinance,3e(Berk/DeMarzo)
Chapter16FinancialDistress,ManagerialIncentives,andInformation
16.1DefaultandBankruptcyinaPerfectMarket
1)WhichofthefollowingstatementsisFALSE?
A)Equityholdersexpecttoreceivedividendsandthefirmislegallyobligatedtopaythem.
B)Afirmthatfailstomaketherequiredinterestorprincipalpaymentsonthedebtisindefault.
C)Intheextremecase,thedebtholderstakelegalownershipofthefirm'sassetsthroughaprocesscalledbankruptcy.
D)Afterafirmdefaults,debtholdersaregivencertainrightstotheassetsofthefirm.
Answer:
A
Diff:
1
Section:
16.1DefaultandBankruptcyinaPerfectMarket
Skill:
Conceptual
2)WhichofthefollowingstatementsisFALSE?
A)Animportantconsequenceofleverageistheriskofbankruptcy.
B)Whetherdefaultoccursdependsonthecashflows,notontherelativevaluesofthefirm'sassetsandliabilities.
C)Economicdistressisasignificantdeclineinthevalueofafirm'sassets,whetherornotitexperiencesfinancialdistressduetoleverage.
D)ModiglianiandMiller'sresultscontinuetoholdinaperfectmarketevenwhendebtisriskyandthefirmmaydefault.
Answer:
B
Diff:
2
Section:
16.1DefaultandBankruptcyinaPerfectMarket
Skill:
Conceptual
Usetheinformationforthequestion(s)below.
MonstersIncorporated(MI)inreadytolaunchanewproduct.Dependinguponthesuccessofthisproduct,MIwillhaveavalueofeither$100million,$150million,or$191million,witheachoutcomebeingequallylikely.Thecashflowsareunrelatedtothestateoftheeconomy(i.e.riskfromtheprojectisdiversifiable)sothattheprojecthasabetaof0andacostofcapitalequaltotherisk-freerate,whichiscurrently5%.Assumethatthecapitalmarketsareperfect.
3)TheinitialvalueofMI'sequitywithoutleverageisclosestto:
A)$133million
B)$147million
C)$140million
D)$150million
Answer:
C
Explanation:
C)VU=
=$140million
Diff:
1
Section:
16.1DefaultandBankruptcyinaPerfectMarket
Skill:
Analytical
4)SupposethatMIhaszero-coupondebtwitha$125millionfacevalueduenextyear.TheinitialvalueofMI'sdebtisclosestto:
A)$125million
B)$111million
C)$100million
D)$116million
Answer:
B
Explanation:
B)Vdebt=
=$111.11million
Diff:
2
Section:
16.1DefaultandBankruptcyinaPerfectMarket
Skill:
Analytical
5)SupposethatMIhaszero-coupondebtwitha$125millionfacevalueduenextyear.TheyieldtomaturityofMI'sdebtisclosestto:
A)12.5%
B)7.8%
C)25.0%
D)5.0%
Answer:
A
Explanation:
A)Vdebt=
=$111.11million
YTM=
-1=.125011or12.5%
Diff:
2
Section:
16.1DefaultandBankruptcyinaPerfectMarket
Skill:
Analytical
6)SupposethatMIhaszero-coupondebtwitha$125millionfacevalueduenextyear.TheexpectedreturnofMI'sdebtisclosestto:
A)25.0%
B)12.5%
C)5.0%
D)7.8%
Answer:
C
Explanation:
C)Vdebt=
=$111.11million
ExpectedReturn=
=.05or5%
Diff:
3
Section:
16.1DefaultandBankruptcyinaPerfectMarket
Skill:
Analytical
7)SupposethatMIhaszero-coupondebtwitha$125millionfacevalueduenextyear.TheinitialvalueofMI'sequityisclosestto:
A)$30million
B)$15million
C)$29million
D)$24million
Answer:
C
Explanation:
C)VL=
=$28.89million
Diff:
2
Section:
16.1DefaultandBankruptcyinaPerfectMarket
Skill:
Analytical
8)SupposethatMIhaszero-coupondebtwitha$125millionfacevalueduenextyear.ThetotalvalueofMIwithleverageisclosestto:
A)$133million
B)$140million
C)$147million
D)$125million
Answer:
B
Explanation:
B)VL=
=$28.89million
Vdebt=
=$111.11million
TotalValue=VL+Vdebt=$28.89+$111.11=$140million
Diff:
2
Section:
16.1DefaultandBankruptcyinaPerfectMarket
Skill:
Analytical
Usetheinformationforthequestion(s)below.
KinstonEnterpriseshasnodebtandadebtobligationof$47millionthatisduenow.ThemarketvalueofKinston'sassetsis$102million,andthefirmhasnootherliabilities.AssumethatcapitalmarketsareperfectandthatKinstonhas5millionsharesoutstanding.
9)Kinston'scurrentsharepriceisclosestto:
A)$20.40
B)$9.40
C)$11.00
D)$10.00
Answer:
C
Explanation:
C)Price=
=$11.00pershare
Diff:
1
Section:
16.1DefaultandBankruptcyinaPerfectMarket
Skill:
Analytical
10)ThenumberofnewsharesthatKinstonmustissuetoraisethecapitalneededtopayitsdebtobligationisclosestto:
A)4.3million
B)4.7million
C)5.0million
D)4.0million
Answer:
A
Explanation:
A)Price=
=$11.00pershare
NumberofShares=
=4,272,728shares
Diff:
2
Section:
16.1DefaultandBankruptcyinaPerfectMarket
Skill:
Analytical
Usetheinformationforthequestion(s)below.
MonstersIncorporated(MI)inreadytolaunchanewproduct.Dependinguponthesuccessofthisproduct,MIwillhaveavalueofeither$100million,$150million,or$191million,witheachoutcomebeingequallylikely.Thecashflowsareunrelatedtothestateoftheeconomy(i.e.riskfromtheprojectisdiversifiable)sothattheprojecthasabetaof0andacostofcapitalequaltotherisk-freerate,whichiscurrently5%.Assumethatthecapitalmarketsareperfect.
11)SupposethatMIhaszero-coupondebtwitha$140millionfacevalueduenextyear.Calculatethevalueofleveredequity,thevalueofdebt,andthetotalvalueofMIwithleverage.
Answer:
VL=
=$19.37million
Vdebt=
=$120.63million
TotalValue=VL+Vdebt=$19.37+$120.63=$140million
Diff:
2
Section:
16.1DefaultandBankruptcyinaPerfectMarket
Skill:
Analytical
16.2TheCostsofBankruptcyandFinancialDistress
1)TaggartTranscontinentalhasavalueof$500millionifitcontinuestooperate,buthasoutstandingdebtof$600million.IfTaggartdeclaresbankruptcy,bankruptcycostswillequal$50million,andtheremaining$450millionwillgotocreditors.Insteadofdeclaringbankruptcy,Taggartproposestoexchangethefirm'sdebtforafractionofitsequityinaworkout.Theminimumfractionofthefirm'sequitythatTaggartwouldneedtooffertoitscreditorsfortheworkouttobesuccessfulisclosestto:
A)50%
B)75%
C)83%
D)90%
Answer:
D
Explanation:
D)Debtholderswillneedtobeatleastaswelloffasifthefirmwentintoliquidation.Inliquidationthedebtholderswouldreceive$450million,howeverifthefirmcontinuestooperateitwillhaveavalueof$500million.Therefore,
$450million=percentownershipfordebtholders×$500totalvalue.
Solvingforpercentownershipgives$450/$500=90%
Diff:
1
Section:
16.2TheCostsofBankruptcyandFinancialDistress
Skill:
Analytical
Usethefollowinginformationtoanswerthequestion(s)below.
Supposethatyouhavereceivedtwojoboffers.ReardenMetaloffersyouacontractfor$75,000peryearforthenexttwoyearswhileWyattOiloffersyouacontractfor$90,000peryearforthenexttwoyears.Bothjobsareequivalent.SupposethatReardenMetal'scontractiscertain,butWyattOilhasa60%chanceofgoingbankruptattheendoftheyear.IntheeventthatWyattOilfilesforbankruptcy,itwillcancelyourcontractandpayyouthelowestamountpossibleforyoutonotquit.Ifyoudoquit,youexpectyoucouldfindannewjobpaying$75,000peryear,butyouwouldbeunemployedforfourmonthswhilesearchingforthisnewjob.
2)IfyoutakethejobwithWyattOil,then,intheeventofbankruptcy,theleastamountthatWyattOilwouldpayyounextyearisclosestto:
A)$45,000
B)$50,000
C)$54,000
D)$75,000
Answer:
B
Explanation:
B)Ifyouquit,youwillbeoutofworkfor4monthssearchingforajobleaving8monthsofemploymentat$75,000peryearor
×$75,000=$50,000
Diff:
1
Section:
16.2TheCostsofBankruptcyandFinancialDistress
Skill:
Analytical
3)Assumingyourcostofcapitalis6percent,thepresentvalueofyourexpectedwageifyouacceptReardenMetal'sofferisclosestto:
A)$133,000
B)$138,000
C)$140,000
D)$144,000
Answer:
B
Explanation:
B)PVRearden=
+
=$137,504.45
Diff:
2
Section:
16.2TheCostsofBankruptcyandFinancialDistress
Skill:
Analytical
4)Assumingyourcostofcapitalis6percent,thepresentvalueofyourexpectedwageifyouacceptWyattOil'sofferisclosestto:
A)$138,000
B)$140,000
C)$144,000
D)$150,000
Answer:
C
Explanation:
C)Ifyouquit,youwillbeoutofworkfor4monthssearchingforajobleaving8monthsofemploymentat$75,000peryearor
×$75,000=$50,000
PVWyatt=
+
=$143,645.43
Diff:
2
Section:
16.2TheCostsofBankruptcyandFinancialDistress
Skill:
Analytical
5)Assumingyourcostofcapitalis6percent,basedonthepresentvalueofyourexpectedwageyoushould:
A)acceptRearden'soffersincethePVofyourexpectedwagewouldbeapproximately$6,000higher.
B)acceptRearden'soffersincethePVofyourexpectedwagewouldbeapproximately$8,000lower.
C)acceptRearden'soffersincethePVofyourexpectedwagewouldbeapproximately$8,000higher.
D)acceptWyatt'soffersincethePVofyourexpectedwagewouldbeapproximately$6,000higher.
Answer:
D
Explanation:
D)Ifyouquit,youwillbeoutofworkfor4monthssearchingforajobleaving8monthsofemploymentat$75,000peryearor
×$75,000=$50,000
PVWyatt=
+
=$143,645.43
PVRearden=
+
=$137,504.45
Difference=143,645.43-137,504.45=$6,140.98←AmountbetteroffbyacceptingWyatt'soffer.
Diff:
3
Section:
16.2TheCostsofBankruptcyandFinancialDistress
Skill:
Analytical
6)WhichofthefollowingstatementsisFALSE?
A)Whenafirmfailstomakearequiredpaymenttodebtholders,itisin
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